My not-so-profound thoughts about valuation, corporate finance and the news of the day!

Wednesday, August 17, 2016

The Ride Sharing Business: Is a Bar Mitzvah moment approaching?

I did a series of three posts on the ride sharing business about a year ago, starting with a valuation of Uber, moving on to an assessment of Lyft, continuing with a global comparison of ride sharing companies and ending with a discussion of the future of the ride sharing business. In the last of those four posts, I looked at the ride sharing business model, argued that it was unsustainable as currently structured and laid our four possible ways in which it could be evolve: a winner-take-all, a losing game, collusion and a new player (from outside). While ride sharing continues its inexorable advance into new markets and new customers, the last few months has also brought a flurry of game-changing actions, culminating with Uber’s decision about a week ago to abandon China to arch-rival Didi Chuxing. It is a good time to take a look at the market again and perhaps map out where it stands now and what the future holds for it.

The Face of Disruption

While there is much to debate about the future of the ride sharing business, there are a few facts that are no longer debatable.

Ride sharing continues on its growth path: Ride sharing has grown faster, gone to more places and is used by more people than most people thought it would be able to, even a couple of years ago. The pace of growth is also picking up. Uber took six years before it reached a billion rides in December of 2015, but it took only six months for the company to get to two billion rides. For just the US, the number of users of ride sharing services is estimated to have increased from 8.2 million in 2014 to 20.4 million in 2020.

Year

Number of US ride sharers (in millions)

% of US adult population

2014

8.20

3.40%

2015

12.40

5.00%

2016

15.00

6.00%

2017

17.00

6.70%

2018

18.20

7.10%

2019

19.40

7.50%

2020

20.40

7.80%

It is globalizing fast: In the same vein, ride sharing which started as a San Francisco experiment that grew into a US business has become global in just a short period, with Asia emerging as the epicenter for future growth. Didi Chuang, the Chinese ridesharing company, completed 1.43 billion rides just in 2015 and it now claims to have 250 million users in 360 Chinese cities. Ride sharing is also acquiring deep roots in both India and Malaysia, and is making advances in Europe and Latin America, despite regulatory pushback.

Expanding choices: The choices in ride sharing are becoming wider, to attract an even larger audience, from carpooling and private bus services to attract mass transit customers to luxury options for more upscale customers. In addition, ride sharing companies are experimenting with pre-scheduled rides and multiple stops on single trip gain to meet customer needs.

Devastating the status quo: All of this growth has been devastating for the status quo. Even hardliners in the taxicab and old time car service businesses recognize that ride sharing is not going away and that the ways of doing business have to change. The price of a New York city medallion which was in excess of $1.5 million before the advent of ride sharing continues its plunge, dropping to less than $500,000 in March 2016. The price of a Chicago cab medallion, which peaked at $357,000 in 2013, had dropped to $60,000 by July 2016.

In short, there is no question that the car service business as we know it has been disrupted and that there is no going back to the old days. If you own a taxi cab or a car service business, the question is no longer whether you will lose business to ride sharing companies but how quickly, even with the regulatory authorities standing in as your defenders.

A Flawed Business Model

Disruption is easy but making money off disruption is difficult, and ride sharing companies would be exhibit 1 to back up the proposition. While the ride sharing option is here to stay and will continue to grow, ride sharing companies still have not figured out a way to convert ride sharing revenues in profits. In making this statement, though, I am relying on dribs and drabs of information that are coming out of the existing ride sharing companies, almost all of whom are private. Piecing together the information that we are getting from these unofficial and often selective leaked information, here is what seems clear:

Raising capital at a hefty pace: In the last two years, the ride sharing companies have been active in raising capital, with Uber leading the way and Didi Chuxing close behding. In the graph below, I list the capital raised collectively by players in the ride sharing business over the last three years and the pricing attached to each company in its most recent capital round.

Ride Sharing Company

Amount Raised in last 12 months (in millions)

Investor

Company Priced at (in millions)

Didi

$7,300.00

Apple, Alibaba, Softbank & Others

$28,000

Uber

$3,500.00

Saudi Arabian Sovereign Fund

$62,500

Lyft

$500.00

GM

$5,500

Ola

$500.00

Didi & Existing Investors

$5,000

Grabtaxi

$350.00

Didi & CIC

$1,800

Gett

$300.00

Volkswagen

$2,000

Via

$100.00

VC

NA

Scoop

$5.10

BMW

NA

At rich prices: As the table above indicates, the investors who are putting money in the ride sharing companies are willing to pay hefty prices for their holdings, with no signs of a significant pullback (yet). Uber, at its current pricing, is being priced higher than Ford or GM. Note that I use the word “pricing” to indicate what investors are attaching as numbers to these companies because I don’t believe that they have the interest or the stomach to actually value them. If you are confused about the contrast between “value” and “price”, please see my blog post on the topic.

From unconventional capital providers: The capital coming into ride sharing companies is coming less from the traditional providers to private businesses and more from public investors (Mutual funds, pension funds, wealth management arms of investment banks and sovereign funds). The reasons for the shift are simple on both sides. Public investors want to be invested in the ride sharing companies because they have visions of public offerings at much higher prices and are afraid to be left on the side lines, if that happens. The ride sharing companies are for it because some of them (Uber and Didi, in particular) are getting too big for venture capitalists to capitalize and perhaps because public investors are imposing less onerous constraints on them for providing capital.

The cash burn at ride sharing companies, by itself, is neither uncommon nor, by itself, troubling After all, to grow, you have to spend money, and a young start up often loses money because of infrastructure investments and fixed costs, and as revenues climb, margins should improve and reinvestment should scale down (at least on a proportional basis). The problem with ride sharing is companies in this business are losing money only partially because of their high growth. In fact, I believe that a significant portion of their expenses are associating with maintaining revenues rather than growing them (ride sharing discounts, driver deals and customer deals). I am afraid that I cannot back up that statement with anything more tangible than news stories about ride sharing wars for drivers, big discounts for customers and the leaked statistics from the ride sharing companies. In effect, it looks like the business model that has brought these companies as far as they have in such a short time period are flawed, because what allowed these companies to grow incredibly fast is getting in the way of converting revenues to profits, since there are no moats to defend.

If you are skeptical about my contention, here is a simple test of whether the cash burn is just a consequence of going for high growth or symptomatic of a business model problem. Assume that the growth ends in the ride sharing business tomorrow and that the ride sharing companies were to compete for existing riders. Do you think that the pieces are in place for these companies to generate profits? I don't think so, as ride prices keep dropping, new ride sharing businesses pop up and the costs continue to increase.

The Bar Mitzvah Moment

In a post in November 2014 on Twitter’s struggles, I argued that every young growth company has a bar mitzvah moment, a time in its history when markets shift their attention away from surface measures of growth (number of users, in the case of Twitter) to more operating substance (evidence that the users are being monetized). I also argued that to get through these bar mitzvah moments successfully, young growth companies have to be managed on two levels, delivering the conventional metrics on one level while working on creating a business model to convert these metrics into more conventional measures of business success (revenues and earnings) on the other.

This may be premature but I have sense that the bar mitzvah moment has arrived or will be arriving soon for ride sharing companies. After an initial life, where investors have been easily sated with reports of more ridesharing usage (number of cities served, rides, drivers etc.), these investors are starting to ask the tough questions about how ride sharing companies propose turning these impressive usage statistics into profits. What’s driving investor uneasiness?

The first factor is that the public investors who have put their money into the ride sharing companies operate under shorter time horizons than many VC investors and the fact that an IPO is not imminent in any of these companies adds to their impatience to see tangible results.

The second factor is that the belief that there will be a winner-take-all, who can then proceed to charge what the market will bear, has receded, as all of the players in the market continue to attract capital.

The third factor is that the possibility that big players like Apple and Google will enter the market is becoming a plausibility and perhaps even a probability and their technological edge and deep pockets could put existing ride sharing companies at a disadvantage.

In my view, it is this perception that change is coming that is leading the flurry of activity that we have seen at ride sharing companies in the last few months. In conventional business terms, the ride sharing companies are trying to shore up their business models, generate pathways to profitability and build competitive advantages. Broadly speaking, these efforts include the following:

Increased Switching costs: The ride sharing companies are working on ways to increase the costs of switching to their competitors, both among drivers (who I described in a prior post as uncontracted free agents) and customers. Uber’s partnership with Toyota, where Toyota will lease cars on favorable terms to Uber drivers, will benefit drivers but will also bind them more closely to Uber, and make it more difficult for them to threaten to go to Lyft for a few thousand dollars. GM’s agreement with Lyft is not as specific but seems to be directed at the same objective.

Cooperation/Collusion: In my ride sharing post in October 2015, I raised the possibility that the ride sharing companies would follow the route of the Mafia in the United States in the middle of the last century, where crime families divided the US into fiefdoms and agreed not to invade each other’s turf. Uber’s decision to abandon the Chinese market to Didi in return for a 20% ownership stake in that company, in particular, seems to be designed to accomplish this no-compete objective. Uber’s China move specifically seems to be designed to stop the mutually assured destruction that a free-for-all fight with Didi will create.

Higher Capital Intensity: Though there is little that is tangible that I can point to in support of this notion, I think that the ride sharing companies now recognize that their absence of tangible assets and infrastructure investment can now operate as an impediment to building a sustainable business. Consequently, I will not be surprised to see more investment by the ride sharing companies in self-driving cars, robots and other infrastructure as part of the phase of building up business moats.

As we witness the breakneck pace of change in the ride sharing business, the big question if you are considering investing in these companies is whether these actions will work in laying the groundwork for profitability. Well, yes and no. If the ride sharing business were frozen to include only the current players, it is probable that they will come to an uneasy agreement that will allow them to generate profits. The problem, though, is that the existing structure of this business is anything but settled, with new ride sharing options popping up and large technology companies rumored to be on the cusp of jumping in. The unquestioned winners in the ride sharing game are car service customers, who have seen their car service costs go down while getting more care service options. .

Uber: An updated valuation

In September 2015, I valued Uber at $23.4 billion, based upon my reading of the market then. In assessing this value, I incorporated what I saw as Uber’s strengths (its reach globally and across many different businesses) and its weaknesses (an out-of-control cost structure and the elimination of many of the insurance and regulatory loopholes that allowed ride sharing to gain such an advantage over conventional car service). In the last year, as I see it, here is how the fundamental story has been impacted by developments in the last year:

Revenues: Uber’s growth continues, measured in cities and rides, though the rate of growth has started to slow down, not surprising given its size. Its decision to leave China, the largest ride sharing market in the world, even if it was the right one from the perspective of saving itself from a cash war, will reduce its potential revenues in the future.

Competition: Before you over react to Uber's exit from China, there is good news in that decision. First,by removing the costs associated with going after the China market from the equation, it reduces the problem of cash burn, at least for the near future. Second, its peace treaty with Didi Chuxing puts the smaller players at risk. Lyft, Ola and Grabtaxi, all companies that Didi invested in to stop the Uber juggernaut, may now be left exposed to competition. Third, in return for its decision to leave the China market, Uber does get a 20% stake in Didi Chuxing.

Costs: On the cost front, the ride sharing business continued to evolve, with most of the changes signaling higher costs for the ride sharing companies in the future. Seattle's decision to let Uber/Lyft drivers unionize may be the precursor of similar developments in other cities and higher costs for both companies. On the legal front, cities continue to throw up roadblocks for the ride sharing companies. Uber and Lyft abandoned Austin, after the city passed an ordinance requiring drivers for both services to pass background checks. One symptom of these higher costs is in the leaked financials from Uber, which suggested that the company lost more than a billion dollars in the first half of 2015.

None of the changes are dramatic but tweaking my valuation to reflect those changes, as well as changes in the macro environment in the last year, my updated valuation for Uber is $28 billion, a little higher than my estimate last year of $23.4 billion. The loss of the China market reduces the total market size but it is offset by a higher market share of the remaining market and a 20% stake in Didi Chuxing. The pricing attached to this Didi stake is $7 billion, but since the same forces that have elevated Uber's pricing are at play across the ride sharing market, I have attached a value of $5 billion to the stake. The picture of the valuation is below:

Clearly, the Saudi Sovereign fund, Goldman Sachs and Fidelity would disagree with me, since their estimated pricing for Uber is more than double my value. They could very well be right in their judgment and I could be wrong, but my valuation reflects my story about the company, which is perhaps not as expansive nor as optimistic as the stories that they might be telling.

What's next?
The ride sharing business is in a state of flux and the next few months will bring more experimentation on the part of companies. Some of these experiments will be with the services offered but more of them will be attempts to get business models that work at converting riders to profits. The ride sharing companies have clearly won the first phase of the disruption battle with the taxicab and car service companies and have been rewarded with high pricing and plentiful capital. The next phase will separate the winners from the losers song the ride sharing companies and it is definitely not going to be boring.

Update: To the many people who have commented about this valuation, I thank you, even if you vehemently disagree with me. To give you some sense of what the feedback has been across my blog, email and twitter, more of you seem to think that I am being too optimistic than pessimistic about Uber's future. Whatever your point of view, I don't claim to have a monopoly on the right story for each company that I value in this blog and the resulting valuation. However, rather than take issue with what you think is wrong with my story/valuation, I would suggest that you download the spreadsheet that is attached and make it your story/valuation. Thus, if you believe that my total market size is too low and/or that my judgment on profit margins too pessimistic, replace them with your own and you will have your own valuation of Uber.

19 comments:

I certainly agree with your story surrounding, competitors and lack profit. I would also had ligation risk seems to be very high in my mind. I don't believe the cab companies will go quietly. It doesn't have to be an Austin scenario, but even some type of tax just to support NYC medallion values.

Do you think these companies could become case studies in private investors waiting too long to reach public markets and cash out or are these ride sharing companies never really in position to go public?

Given the focus on automated ride sharing the capital intensity of the business is likely to actually rise dramatically over the next decade as they need to build out their own fleet or compete against manufacturers and their automated fleets.

It should be noted that manufacturers like Tesla soon (or the likes of Toyota a few years down the line) would have incentive to offer their car "spare capacity" ride sharing network at cost as they making money elsewhere, much as Google offers services for free and makes money on their core ad network.

The value of the ride sharing network is high due to increased availability before automated fleets become a reality, but as you note switching costs are still pretty low, making long-term sustainable margins questionable.

Finally I should note that driver economics in several states, such as Detroit, have already reached the level whereby mileage revenue has dropped below government estimates for mileage costs (54c/mile). This means that, especially given the onerous, sometimes subprime leasing terms of the cars, some drivers are working for free or near free already, with most of their pay basically coming from deferred car depreciation.

I think the deal with Didi gave Uber China a 20% stake in the combined entity. Uber China is owned by Uber, Baidu and other investors. I think Uber Inc owns approximately 30% of Uber China, so the actual stake in the Didi/Uber China combination is closer to 6%, instead of the 20% you take into account in your model.

I don't understand why they keep calling it rideshare, it is a taxi service that has been able to grow due to technology allowing riders to connect with drivers, very few drivers 'share' their car but rather this is their full time job, prior to that they were driving for a cab service or doing something else. At least in the US cities I have been in and in conversations with drivers. So just like taxis they should be regulated and pay taxes just like yellow cabs (in NYC) are, otherwise they are not competing on a level field.

Very interesting point but think your valuation misses one massive detail - the take rate! Self-driving cars mean take rates at 15% are way too conservative, since they will not have to pay any commission to drivers.

Already they have 100 cars ready to go in Pittsburgh for "drivers" who will probably be paid $10 an hour. That means the take rate is only going up. Doubling the take rate to 15% means double your terminal value, which is over 100% of your valuation.

Cashmoneyfman,I saw the Pittsburgh news story as well and it is interesting because its effect on value is mixed. It is true that you get to keep all of the revenues now (and don't have to share with the driver) but this is a capital intensive model where you have to invest massive amounts in cars to produce rides on the scale that I have estimated. It may be the ride sharing game of the future but if so, does Uber have a competitive advantage against Apple, Google or even Tesla that have the technological edge as well as far more capital than Uber does?

Thanks for your detailed post on Uber's valuation.In your post you mentioned that Uber has no no moats to defend, meaning no competitive advantage. Isn't that the case with other e-commerce companies or companies with marketplace models? What competitive advantage do companies such as Flipkart, Snapdeal or even Amazon's e-commerce business have to boast of such huge valuations? I agree that these companies can get funds / capital to take care of their expenses/burn-rate for a much longer time frame, thereby giving a higher probability of success. But, aren't these business models flawed as well?

If you have done a valuation of Amazon or any other such companies could you please provide the link?

I don't think people are valuing these companies on their current business. The endgame seems to be a fully automated transportation network. Such a thing might even displace personal car ownership and public transit.

I think people view that outcome as winner-takes-all because larger networks will receive better economies of scale and be more likely to have cars immediately available upon request.

They are willing to burn huge amounts of cash to own the market. Ride-sharing may not be currently profitable, but once (or if) technology catches up, market-share in this space will become incredibly valuable.

Obviously this game becomes extremely dangerous if self-driving cars do not materialize on time.

Hari,You may be right but even if the end game is self-driven cars, why would any of the existing players have an advantage in that game (which will be capital intensive, tech-driven games where the auto and the tech companies will have the advantage over the Ubers and Didis of the world?

Looking into what Mike mentioned... On the input sheet, cell D11's label should read "B4. Double market size" rather than the "B4: Double market it currently reads. Using a colon instead of a period here mixes up the vlookup in cell B9 and results in a 7.26% market growth rate flowing through the model (yielding a valuation of ~$24bn) instead of your published valuation of ~$28bn (which is indeed based off of the 10.39% market growth rate).

Doesn't seem to result in any impact to your published valuation, just the default template layout.

Quick question for you - in the competition paragraph you say that "Second, its peace treaty with Didi Chuxing puts the smaller players at risk. Lyft, Ola and Grabtaxi, all companies that Didi invested in to stop the Uber juggernaut, may now be left exposed to competition" but wouldn't this decrease competition for the other Chinese competitors like UCAR now that the new regulations in China don't allow for pricing below costs and given Didi/Uber will control >90% of the market Didi/Uber will focus on profitability over market share? Would love to hear your thoughts on whether or not you think Chinese competitors like UCAR (or the other Chinese rideshare competitors) will be able to compete effectively vs. Uber/Didi in China or will eventually go bankrupt. Thank you for your time!

Anonymous,I think that the business is still fundamentally unstable all over the world. That is why I think that the peace treaty is only the first phase of a larger battle. Uber has opened the second phase with its investment in self-driving cars in Pittsburgh and I have a feeling that both Didi and Uber are going to use their access to capital to try to introduce barriers to entry in this business (more capital intensity, for instance) to put their smaller competitors at a disadvantage. The question is whether they can compete against Google, Apple and Volkswagen in a capital-intensive, technology-driven business.

I am glad to see a professional evaluate Uber and other Ride Hailing(If one entity charges a fee for service, they are not sharing, whether they do it part or full time) I have many questions. Does the fact Uber pays no taxes in many of the non US countries have an effect on the valuation? In Canada transactions are immediately transferred to the Netherlands to shell companies. and disappear. Unfortunately it is legal in Canada? Would agreeing to real criminal background checks somehow hurt the valuation?

As Uber has been caught in many lies, and is sued regularly. do those that invest ignore the companies' ethics and how it may affect its ability to make profit? Or is are those though of accepted business practises, though uber has been involved in more than usual?

Thank you, hope you continue to write on the subject, All the best Barry Wilson